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The Search for Stability
Uncertainty, Fear Should Ease as 2003 Progresses
By Russell Investment Group
February 11, 2003
Once the war clouds over Iraq have cleared, the market is likely to return to its historical pattern, Russell money managers say. That pattern was disrupted by the remarkable events of the last five years as the market rocketed to dizzying record heights and then wiped out almost all those gains as it came crashing down.
As the markets settle down, growth stocks look likely to reassert themselves, managers suggest. Almost without exception they are cautiously optimistic about the market's performance this year.
But for now, managers and analysts agree, Iraq is hovering over the markets, scaring some investors and making it difficult for others to decide how to invest their money.
"I know it is a scary market," says Russell's Chief Investment Strategist Ernie Ankrim. "I have talked with institutional managers and individuals and it is no surprise there is fear among all investors."
The sharp rise in the price of gold — it rose 24% in 2002 and continues to climb this year — reflects fear of geopolitical risk and not a fear of inflation, Ankrim adds. Gold generally rises in the face of inflationary threats or in times of international political tension. It is the latter that is driving this recent run-up.
But, he adds, gold prices are likely to continue rising only if the level of uncertainty surrounding Iraq and the US actions there increase. "No one wants a war, but it is uncertainty about the war that the market dislikes more than anything."
Bond Market Also Impacted
Iraq also overhangs the fixed-income market, agrees Jim Lukens, a Russell fixed-income research analyst. Although managers expect interest rates to rise this year, that forecast could be derailed by world events. Iraq is the big wild card "and managers don't know how it's going to affect the market," Lukens says.
Internationally, too, geopolitical risks remain high, says Russell's Phil Hoffman, who monitors the markets from his London office. Before the Iraqi situation is resolved one way or another, it is difficult to see managers using their cash to invest in any specific direction, he says.
But Russell analysts say managers generally are confident that the Iraqi situation will be resolved and will not have a major impact on the market for the entire year.
It is likely the outcome in the Middle East will be less uncertain before the year is out, Ankrim points out. When the costs and outcomes are more clear, much of the "fear discount" will likely be reduced, and markets will have most likely improved in anticipation of such clarity.
Getting Past Geopolitical Concerns
Once concerns are diminished regarding situations in Iraq and North Korea, Russell money managers see a gradually improving economy during the year, but no one is betting on a strong spurt, says Dennis Jensen, a Russell US research analyst who specializes in value managers.
"Managers expect the market returns this year to be in the high single digits," Jensen adds. "Volatility is expected to be lower this year than it was last year."
Managers also see the pendulum swinging back to growth stocks after a couple of years during which value outperformed growth.
"Small-cap value stocks looked extremely attractive three years ago, but, after three years of phenomenal performance, they don't look as attractive to managers as they did before," Jensen says. "In fact, the opposite is true."
US Government Stimulus, Interest Rates Help Growth
Russell's Brad Lawson agrees. "It has been a brutal environment for growth manager returns, but they feel pretty good about these stocks going forward," he says. Factors stirring optimism are the fiscal stimulus being provided by the American government and favorable interest rates. These aspects point to modest revenue growth and improving corporate profits, Lawson says.
Investors appear to be moving away from defensive stocks to those that are more dependent on the cyclicality of the economy, he adds. Also, the focus is likely to shift from the consumer, whose spending has sustained the lackluster growth in the economy, to business spending, Lawson adds.
"Our managers believe the desire — and need — to spend and build infrastructure will cause the growth to be led by businesses, not consumers. It is unrealistic to expect more growth out of consumers. They are tired."
Even though potential war is a major factor overhanging them, the markets look like they are returning to their historical patterns, says Russell's Global Chief Investment Officer, Randy Lert.
"The markets seem to be returning to normal after one of the most remarkable five-year periods I've seen in my career," he adds.
This period included a time when investors, driven by momentum investing, drove technology stocks to highs that bore little relationship to their underlying value. In the last few years, after the bubble burst, the markets have been recalibrating.
The result was a tough and challenging environment in which the fundamental values of stocks were not necessarily rewarded, Lert says.
"A return to normalcy bodes well," he adds. "We can look forward to equity risk premiums that are more in line with historical norms."
Copyright© Frank Russell Company 2002. All rights reserved. See Legal Information. Date of first use: February 11, 2003.
The information and any statistical data contained herein have been obtained from sources which we believe to be reliable but we do not represent they are accurate or complete and they should not be relied upon as such. All opinions expressed and data provided herein are subject to change without notice.
This is a publication of Russell Investments Canada Limited. It should not be construed as investment, legal, or tax advice. The contents are intended for general information purposes only, and you are urged to consult your own investment, legal, or tax advisor concerning your own situation and any specific investment questions you may have.
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